Bank of Japan Surprises Market with Rate Move

Wednesday, 6 October 2010

In what was probably the most surprising move in the recent history of financial markets, the Bank of Japan announced Tuesday that it had voted unanimously to lower the official cash rate in the country. The rate - which was already low compared to global standards, has now dropped even further to be that much closer to 0.00%.

As of 4:00pm JST, the official cash rate is now at 0.25% - down from 0.50% earlier in the day. Whilst many market participants didn't predict that this move was coming - or even necessary - the commentary from the Japanese central bank which followed the announcement summed up the position clearly.

The Japanese believe that the USD/JPY and other important Yen currency pairs have been suffering unnecessarily lately. For Japan, suffering comes in terms of a stronger Yen - not the other way around.

Hence, the move to lower official interest rates might be a move partially to make the Yen more unattractive for investors to hold, and also partially to make borrowing for exporters a lot cheaper.

Both of these ideas - which both are of equal value - would stir up competition in the market, and further encourage exporter development and growth... something which has unfortunately been missing from the market recently.

As soon as the announcement was made by the Japanese central bank, markets reacted to the news strongly. This was especially the case because nobody predicted that this move would take place in the current market environment.

The Nikkei was up 1% early in trade, and closed the day 1.47% higher overall. Usually, reductions in the borrowing rate follow on from a reduction in the official cash rate, and therefore this makes margin investments - usually in equities - a lot cheaper for investors.

In the Forex markets, the USD/JPY was trading at 83.99 shortly after the announcement, settling to 83.70 after the close of the market.

With these types of things happening regularly in the Japanese economy (i.e. these types of surprises) - investors were surprised by the move, but not entirely dumbfounded. The Japanese has been throwing all of its tools at the market recently in order to decrease the value of the Yen - especially in the USD/JPY currency pair, so many people are looking at this rate drop simply as another desperate attempt by the central bank to encourage the markets to look higher in the USD/JPY pair.